Chapter 11 Flashcards
Relevant information has two characteristics:
characteristics:
–It occurs in the future
–It differs among the alternative courses of action.
Relevant costs are
Relevant costs are expected future costs.
•Relevant revenues are expected future revenues
Past costs (historical costs) are never
Past costs (historical costs) are never relevant and are also called sunk costs.
Managers divide the outcomes of decisions into two broad categories: quantitative and qualitative.
Quantitative factors are outcomes that are measured in numerical terms.
•Qualitative factors are outcomes that are difficult to measure accurately in numerical terms, such as satisfaction.
Although quantitative nonfinancial factors and qualitative factors are difficult to measure in financial terms, they are important for managers to consider.
Incremental cost
Incremental revenue
Incremental cost—the additional total cost incurred for an activity.
Incremental revenue—the additional total revenue from an activity.
Differential cost
Differential revenue
Differential cost—the difference in total cost between two alternatives.
Differential revenue—the difference in total revenue between two alternatives.
Types of Decisions that Need to be Made
One-time-only special orders (Slide #15)
•Short-run pricing decisions (Slide #19)
•Insourcing vs. outsourcing (Make-or-Buy) (Slide #20)
Product-mix decisions with capacity constraints (Slide #24)
–These are decisions that managers make about which products to sell and in what quantities. These decisions usually have only a short-run focus because they typically arise in the context of capacity constraints that can be relaxed in the long run.
Bottlenecks, Theory of Constraints, and Throughput-Margin Analysis (Slide #26)
–The theory of constraints describes methods to maximize operating income when faced with some bottleneck and some bottleneck operations. To implement TOC, we define and use three measures:
●Throughput margin
●Investment equals the sum of materials, R&D costs and capital costs of equipment and buildings
●Operating costs equal costs of operations (other than direct materials)
Customer profitability and relevant costs (Slide #29)
–Managers must make decisions about adding or dropping a product line or business segment, but if the cost object is a customer, managers must decide about adding (Slide #32) or dropping customers (Slide #31).
•Branch/segment: adding or discontinuing (Slide #31)
•Equipment replacement (Past costs are irrelevant) (Slide #34)
One-Time Only Special Orders
Decision: To accept or reject special orders when there is idle production capacity and the special orders have no long-run implications.
•Decision rule: Does the special order generate additional operating income?
–Yes—accept
–No —reject
•Compares relevant revenues and relevant costs to determine profitability.
Managers should avoid two potential problems in relevant–cost analysis:
Avoid incorrect general assumptions such as that “All variable costs are relevant and all fixed costs are irrelevant.” Even in our simple example, we had irrelevant, variable marketing costs.
2.Be aware that unit-fixed-cost data can potentially mislead managers in two ways.
Unit-fixed-cost data can potentially mislead managers in two ways:
Fixed unit costs might include irrelevant costs; costs that will not change whether or not the one-time only order is accepted or not.
•If using the same unit fixed costs at different output levels, managers may reach erroneous conclusions. Total fixed costs should be used.
Short-Run Pricing Decisions
A special order decision is, in many respects, a short-run pricing decision.
•Sometimes, the decision is simply about setting an acceptable price.
•Remember the decision rule?
•Any price above incremental costs will improve operating income; however, consideration must be given to capacity constraints, current market conditions, customer demand, competition, etc.
Insourcing V Outsourcing and Make-or-Buy Decisions
Outsourcing is purchasing goods and services from outside vendors.
•Insourcing means you’ll produce the good (or provide the service) within the organization.
•Decisions about whether to insource or outsource are called Make-or-Buy decisions.
•Opportunity Costs are the contribution to operating income forgone by not using a limited resource in its next-best alternative use.
A bottleneck
is a phenomenon where the performance or capacity of an entire system is limited by a single or limited number of components or resources. The term bottleneck is taken from the ‘assets are water’ metaphor. As water is poured out of a bottle, the rate of outflow is limited by the width of the conduit of exit—that is, bottleneck. By increasing the width of the bottleneck one can increase the rate at which the water flows out of the neck at different frequencies. Such limiting components of a system are sometimes referred to as bottleneck points.
The Theory of Constraints (TOC) describes methods
maximize operating income when faced with some bottleneck and some nonbottleneck operations. The TOC defines these three measures:
•Throughput margin
•Investments
•Operating costs
•The objective of the TOC is to increase throughput margin while decreasing investments and operating costs. The TOC focuses on managing bottleneck operations.
Four steps to manage bottleneck operations
Recognize that bottleneck operations determine the contribution margin of the entire system.
- Identify the bottleneck operations.
- Keep the bottleneck operation busy and subordinate all nonbottleneck operations to the bottleneck operation.
- Take actions to increase the efficiency and capacity of the bottleneck operation.
